Facebook Bought Oculus Because It Could

Facebook Inc.'s plan to buy Oculus VR Inc., which makes virtual-reality headsets, for about $2 billion may seem like an odd fit for a company that makes money by selling poorly targeted ads. But not if you consider the incentives of Facebook's managers, particularly founder and chief executive officer Mark Zuckerberg.

Remember that Facebook just spent about $19 billion to buy WhatsApp Inc. and that Facebook had tried -- and failed -- to buy Snaptchat Inc. for at least $3 billion. These are big numbers, but relatively small amounts compared with Facebook's market valuation of about $162 billion.

Facebook is profitable, unlike many hot Internet companies, but its earnings of about $1.5 billion last year offer a tiny foundation for its towering market value. Google Inc., which also makes most of its money by selling ads, is worth about 2.4 times as much as Facebook even though it earns almost nine times as much profit. In other words, Facebook's valuation is only justifiable if you expect its earnings to grow much faster than Google's.

The problem for investors is that Facebook probably can't generate that growth from its core business since it already dominates the market for social networking. One solution: new hit products. Facebook's 6,000-plus employees are presumably hard at work on this, but buying younger companies is also a reasonable approach.

Zuckerberg's statement about the Oculus acquisition explains this thinking. As he sees it, smartphones are becoming passe, so a growing tech company needs to be willing to buy new businesses with the potential to turn ideas from science fiction into reality. (Personally, I'd bet that the future lies with implants rather than clunky devices that look like this and give you motion sickness but then again I'm not worth $29.1 billion.)

It just so happens that the growth expectations that encourage Zuckerberg's shopping spree also make it possible. Facebook shares are a form of currency that the company can produce on demand, so a high market value increases corporate spending power. The only limit to this buy-everything strategy is whether investors are willing to keep supporting the share price as they continue to get diluted with each new acquisition. So far they have been quite tolerant, but it isn't obvious why you'd want to pay so much for shares in a company that is starting to look a lot like a late-stage venture investor.

To contact the writer of this article: Matthew C. Klein at mklein62@bloomberg.net.

To contact the editor responsible for this article: James Greiff at jgreiff@bloomberg.net.

Matthew C. Klein writes for Bloomberg View about the economy and financial markets. He previously wrote for the Economist magazine and its economics blog, Free Exchange.
Before that, Klein was a research associate at the Council on Foreign Relations, where he spent more than two years studying the history of the Federal Reserve and the intellectual history of monetary economics for an upcoming book by Sebastian Mallaby. He also worked at Bridgewater Associates, where he studied the economies of Central and Eastern Europe and advised institutional investors on asset-liability management. Klein has a bachelor's degree in history from Yale University. Originally from Chicago, he lives in New York.
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